Banks Will Take The Bailout Bucks But Will They Lend It Out?

So
will the $250 billion Hank Paulson plans to inject into banks
unfreeze the credit markets? The Treasury Department held a
briefing for journalists today to explain why they think the
bailout will work. We didn’t go to the meeting but Luke Mullins
did.

1. Healthy banks will participate in the program because the
terms are favorable. Although participating banks will be forced
to accept executive compensation restrictions, government
officials said the initial annual dividend rate of 5 percent
makes the capital "attractive." One official said his agency has
received "pretty significant" interest from financial
institutions about participating in the program. Another said he
expected "a lot of applications."

2. Banks will then lend out the cash because doing so makes the
most economic sense. The officials argued that because banks will
be restricted from using the cash to buy back shares or increase
dividends, using the capital for lending is the most profitable
way to make a return.

3. There are good lending opportunities out there. The tighter
underwriting standards and higher down payment practices now
being employed by the mortgage industry have created "good
lending opportunities" for banks, a government official said. The
cash injections will help alleviate the capital constraints that
have been working to prevent such activity, the official said.

We
hope it works out! But so far, banks don’t seem that
interested in ramping up their lending. Libor has come down a
bit, but remains at historically astronomic levels. But a look at
what’s happened in the mortgage markets suggests that maybe it
won’t be so easy. Mortgage rates have remained high despite the
ever-cheaper money available from the Fed. Banks remain wary of
credit risk, and giving them additional capital won’t cure that
wariness.

This is a key point raised by
Anna Schwartz in her WSJ interview over the weekend.
Paulson’s bailout is preventing the market process from creating
transparency about the financial conditions of banks. That lack
of transparency keeps fear alive, which holds the banks back from
lending.